Sir Ian sat on the 'top table' with Lord Levy at the Jewish Community Security Trust annual dinner despite police guidelines which discourage officers from consorting with suspects on bail.

The Home Secretary John Reid was on the same table.

Dozens of fellow guests at the black-tie function - attended by 1,200 people - looked on in astonishment as Sir Ian and Lord Levy dined together.

They were left even more surprised when Lord Levy - who is on police bail after being arrested over allegations he broke electoral law and attempted to pervert the course of justice spoke to Sir Ian later in the evening and spoke to him for up to two minutes.

The extraordinary encounter happened as Sir Ian's officers prepare to submit a final report on the cash for honours affair to the Crown Prosecution Service.

"It is staggering that Sir Ian agreed to be seated so close to Lord Levy at such a critical time in the cash for honours investigation," said one observer.

The incident is the latest in a series of controversies to engulf the Scotland Yard chief since he took over as head of Britain's biggest force two years ago.

Last month it was claimed that Sir Ian, once dubbed Labour's favourite police chief, had told Cabinet ministers that Tony Blair would be cleared of any wrongdoing in the cash for honours inquiry.

Sir Ian denies he made such a comment.

Damian Hockney, a member of the Metropolitan Police Authority which oversees the running of Scotland Yard, said the Commissioner should not have dined with Lord Levy.

He said: "The Commissioner is inviting criticism of his judgment by sitting at the same table as a key suspect who is at the centre of the most sensitive police investigation of recent times.

"It is vital that this investigation is seen to be completely independent of any possible interference."

LibDem MP and anti sleaze campaigner Norman Baker said: "I am surprised at suggestions that the Metropolitan Police Commissioner would find himself in a position where he ends up shaking hands with someone who is on bail.

"It is in the interests of both the police and Lord Levy for there to be distance between the two sides at this point.

"Such events are best avoided as they can seem to compromise proper police inquiries. If I were Ian Blair I would make sure I wasn't in that position."

In a statement, Scotland Yard said Sir Ian Blair was one of more than 1,200 guests at the Community Security Trust annual dinner in central London on February 26.

It added: "He was aware that Lord Levy would be present and acted in accordance with police instructions about meeting people on police bail, informing an appropriate senior officer both before and after the event.

"The Commissioner was one of eighteen guests on the 'top table' along with Lord Levy although at the Met's request they were not seated close to each other.

"The Commissioner did not discuss details of the investigation into alleged abuse of honours with Lord Levy."

In addition to informing a senior officer about his meeting with Lord Levy, Sir Ian also contacted the chairman of the Metropolitan Police Authority, Len Duvall.

Yard regulations say officers should tell colleagues if they meet someone on police bail - the rule was introduced to prevent corruption.

Last month Sir Ian again faced calls to quit after being accused of undermining the cash-for-peerages inquiry by briefing ministers on the progress of the investigation.

MPs said Sir Ian should consider his position over claims that he tried to pre-empt the results of the criminal probe.

Senior Government sources alleged that Britain's most senior policeman had been 'sounding off' in conversations with ministers including Chancellor Gordon Brown - who, crucially, is a witness in the inquiry.

Government sources claimed he told senior Labour politicians that the investigation will be finished within weeks.

One said: "Sir Ian was extremely candid. We were surprised he could talk about it. He seemed to be giving the impression that this was all a big fuss that would soon die down."

Previous rows concerning Sir Ian include secretly recording telephone conversations with the Attorney General and three police watchdog officials.

His force's watchdog, the Metropolitan Police Authority, said his conduct was "totally unacceptable".

He also questioning why the Soham killings of Holly Wells and Jessica Chapman attracted so much media interest - comments that prompted widespread fury.

It is also alleged he put out misleading public statements in the aftermath of the shooting of innocent Brazilian Jean Charles de Menezes.